Federal Fiscal Court ruling: Merger at fair market value: no negative goodwill

Fair market value in the closing tax balance sheet pursuant to section 11 of the Reorganisation Tax Act

In the case of a merger of one corporation into another corporation, the assets transferred must generally be recognised at fair market value in the tax closing balance sheet of the transferring corporation, “including intangible assets acquired without consideration or internally generated intangible assets” (section 11(1) sentence 1). Book values or intermediate values may be recognised only upon application and subject to the conditions of section 11(2) sentence 1. If this fails – for instance because Germany’s right to tax the gain from the sale of the transferred assets is excluded or restricted at the level of the receiving corporation (section 11(2) sentence 1 no. 2, “loss of the German right to tax” (“Entstrickung”)) – all hidden reserves are realized. This also includes self-created goodwill, which would otherwise be subject to the recognition prohibition under section 5(2) of the Income Tax Act (Circular of the Federal Ministry of Finance of 2 Jan 2025, Federal Tax Gazette [Bundessteuerblatt–BStBl.] I 2025, p. 92, para. 11.03 in conjunction with para. 03.05).

The term fair market value, which applies where there are no specific provisions governing valuation for tax purposes (Federal Tax Court judgment of 11 Apr 2018, file ref. I R 34/15, Federal Tax Gazette II 2020, p. 201, para. 24), is not defined in the Reorganisation Tax Act. Section 9 of the Valuation Act [Bewertungsgesetz–BewG] is authoritative (Federal Tax Court judgement of 12 Apr 2017, file ref. I R 36/15). However, this provision fails in the case of goodwill, since goodwill cannot be sold separately and therefore has no price obtainable in the ordinary course of business. The Federal Tax Court therefore determines it by way of a “norm-specific definition” as a residual amount: the total value of the transferred aggregate of assets (“Sachgesamtheit”) less the balance of all other transferred assets and liabilities at fair market value.

In the case at issue, a German holding GmbH had been merged into its Austrian parent company, with effect for tax purposes as of 31 December 2011, by way of a cross-border merger (sections 122a and following of the Reorganisation Tax Act, old version; now sections 305 and following). An application for book values was ruled out under section 11(2) sentence 1 no. 2, as no German permanent establishment remained to which the transferred assets could have been allocated. The valuation report determined the value of the participations separately using the “sum-of-the-parts method”. For the remaining holding function, comprising group charges allocated on the basis of revenue plus a 5% mark-up as well as non-allocable costs, such as those relating to the controlling of investments, the valuation resulted in a negative DCF value of approximately EUR 3.2 million. The company recognised this as negative goodwill, thereby reducing the transfer gain. The tax audit refused this, referring to the net asset value as the lower limit of the valuation. The Hessian Fiscal Court [Finanzgericht–FG] (judgement of 2 Dec 2021, file ref. 4 K 130/20) upheld this on the ground that the costs, being administrative costs incurred for the shareholder, did not “attach” to the business.

No negative goodwill, but recognition of hidden liabilities

The Fiscal Tax Court nevertheless set aside the lower court’s decision and remanded the case for further proceedings (section 126(3) sentence 1 no. 2 of the Tax Court Code [Finanzgerichtsordnung–FGO]). In doing so, it made three distinct findings:

– No negative goodwill: According to established case law, negative goodwill is not an asset capable of being recognised in the balance sheet (e.g. Federal Tax Court judgement of 21 Apr 1994, file ref. IV R 70/92, Federal Tax Gazette II 1994, p. 745). Above all, however, the value of the aggregate of assets must, by analogy with section 11(2) sentence 3 of the Valuation Act, be set at no less than the net asset value, so that the residual calculation cannot become negative (paras. 46 and following; likewise Circular of the Federal Ministry of Finance of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, para. 11.04 in conjunction with para. 03.07). The chamber also relies on consistency with section 13(1) of the Reorganisation Tax Act, since the net-asset-value floor would in any case apply to the valuation of the shares at shareholder level (paras. 53 and following).

– No substitute solutions: Unlike in the case of the acquisition for consideration of an interest in a partnership (Federal Tax Court judgment of 21 April 1994, file ref. IV R 70/92, Federal Tax Gazette II 1994, p. 745) or additional payments made in connection with the acquisition of shares (Federal Tax Court judgment of 26 April 2006, file ref. I R 49, 50/04, Federal Tax Gazette II 2006, p. 656), neither a write-down of the transferred assets nor the recognition of a balancing liability is permissible. A merger does not involve a quantified consideration. Moreover, any such approach would circumvent the net asset value as the minimum valuation floor (paras. 56 and following).

– But recognition of hidden liabilities: In the closing balance sheet under section 11(1) sentence 1, the tax prohibitions on recognition – in particular the prohibitions on recognising liabilities – do not apply (paras. 20 and following; likewise Circular of the Federal Ministry of Finance of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, paras. 11.03, 03.04 and 03.06). Provisions for uncertain liabilities must be recognised even where, for example, section 5(2a) of the Income Tax Act would preclude them, as must provisions for anticipated losses from pending transactions (“Drohverlustrückstellungen”) notwithstanding section 5(4a). The benchmark is section 249(1) sentence 1 of the Commercial Code [Handelsgesetzbuch–HGB]. The case law from the period before the prohibitions on recognising liabilities were introduced is to be drawn upon (paras. 28 and following). Pure provisions for internal expenses (“Aufwandsrückstellungen”), on the other hand, remain inadmissible, since section 11 of the Reorganisation Tax Act does not establish “any right of invention under tax accounting law” (para. 24).

The referral back to the Fiscal Court rests solely on the last point: the Fiscal Court must clarify whether the uncovered holding costs are based on obligations to provide services to the group companies – in which case a provision for anticipated losses may be considered – or are incurred in the company’s own business interest and are therefore not eligible for a provision (para. 82).

Hidden liabilities instead of negative goodwill: Practical implications

The decision shifts the focus: it is not the value of the business as a whole but the individual liabilities that determine whether negative earnings prospects reduce the transfer gain. In this context, the mechanics of the residual calculation must be taken into account. Where the value of the business exceeds the net asset value, recognised hidden liabilities merely increase goodwill (para. 40) and ultimately have no effect. They take effect precisely where the net-asset-value floor applies, because they lower that floor itself. Valuation reports should therefore not stop at a (negative) DCF value, but should identify and document the underlying adverse circumstances as specific obligations towards third parties or anticipated losses from continuing contractual obligations (“Dauerschuldverhältnisse”) (e.g. group cost allocation or service agreements).

The asymmetry remains problematic: positive earnings prospects are fully captured through goodwill, negative ones only to the extent that they are reflected in liabilities eligible for provisions. The Fiscal Tax Court argument that the expenses are not lost for tax purposes because they are to be taken into account at the level of the receiving corporation (para. 61) holds only to a limited extent in an outbound merger [Hinausverschmelzung]: the future expenses will no longer reduce the German tax base. In this respect, the Federal Tax Court refers to the lack of harmonisation (para. 79).

In domestic mergers at fair market value, the follow-up question also arises as to how the receiving corporation must carry forward the provisions taken over that are otherwise subject to a prohibition on recognition as liabilities (section 12(1) sentence 1; section 5(7) of the Income Tax Act). Finally, the principles of the judgement are likely to be transferable to the closing balance sheet under section 3(1) sentence 1 of the Reorganisation Tax Act in reorganisations into partnerships, which the Federal Tax Court repeatedly draws on in its reasoning.

In later reorganisations, section 4f of the Income Tax Act must additionally be applied at the level of the transferring corporation (Circular of the Federal Ministry of Finance of 2 Jan 2025, Federal Tax Gazette I 2025, p. 92, paras. 03.06 and 04.16). The provision does not concern the recognition of the hidden liability in the tax closing balance sheet, but rather the timing of the deduction of the expense arising from its transfer, which must generally be spread over 15 fiscal years. At the level of the receiving corporation, section 5(7) of the Income Tax Act is the corresponding provision. However, section 4f did not yet apply to the case at issue, with its effective transfer date of 31 December 2011: the provision was only introduced by the AIFM Tax Adjustment Act [AIFM-Steuer-Anpassungsgesetz–AIFM-StAnpG] of 18 December 2013 and applies in principle for the first time to financial years ending after 28 November 2013.